What do you do in your spare time? I read bankruptcy dockets.

On April 16th, 2012, a company based in Ronkonkoma, New York filed for bankruptcy. The company's name is Integratas Security Corporation. Integratas employs 366 people who provide day to day guard services across the tri-state area. Because of increased competition (including a competitor started by one of its former employees) in the face of weakening customer demand, Integratas is unable to pay its debt and has filed bankruptcy in the Eastern District of New York (Central Islip).

In its first day motions, Integratas notes that it has entered into an Asset Purchase Agreement (APA in the bankruptcy world) with one of its competitors. The terms of the APA are as follows:

  • $750,000 consideration, with which $250,000 is due at the close of the sale, with the balance paid out based on a formula that could ratchet the price down.
  • In exchange, purchaser will receive assumption and assigned of service contracts of Integratas, vehicles and equipment, and the trademark name
  • The full purchase price is predicated on producing revenue of at least $6.9 million, one year subsequent to closing
  • There is a customary break up fee and overbids
There will be an auction to determine if there will be a higher bid for the company. That auction is scheduled for June 6th, 2012 in Jericho, NY. Competing bids are due by the 1st of June.

For those interested, here is the docket: Integratas Pacer Link

When people ask me what I do for a living, I tell them I invest in junk bonds and bankrupt companies. Most people's knowledge of distressed investing ends with Richard Gere

Let's run a quick thought experiment: In 20 years, of the four items below, what is the most likely to be around?
  1. Facebook
  2. Google
  3. Apple
  4. bankruptcy
Since the dawn of lending, millions of individuals and institutions have mispriced their ability to repay their debts.  I am not quite sure if it is more hope or more greed, but, usually at the most inopportune times, lenders extend far too much credit, and debtors take on far too much of a burden, and the result is bankruptcy (I will use the term bankruptcy and restructuring interchangeably in this post). Bankruptcy is here to stay.

The problem of course is bankruptcy is ugly. Our representation in the press is this:

And bankruptcy is complex. It is oh, so complex. Seth Klarman has publicly stated that Baupost had one analyst that just looked at Enron, solely, for a number of years. Complex org charts, upstream vs downstream guarantees, rejection claims, pension negotiations, dual tracks, conflicting valuation assessments, Rule 2004 discovery, releases, etc is just the beginning.

And it is opaque. The most disgusting business out there are transcription services that charge $500-$1000 for a copy of a court transcript. Someone tell me how to disrupt that, and I may just invest in your company immediately. There is a service that arguably 1% of the investing world (CourtCall) knows about that one must register with, and then pay $50, to listen to court proceedings. PACER still charges you for access fees. The time information is posted to a docket to what happens in the court can take days. Club deals abound like no where else.

But all these create investment opportunities that I think are unparalleled in the public investment universe.

One of the anecdotes Warren Buffett, distressed investor himself, tells students is that long ago, he would pick up Moody's stock manuals and start with A. It is a good exercise. Via the media, the public is exposed to maybe 10% of the U.S. invest-able stock market. By relentlessly going through the alphabetized list of names, enterprising investors can catch bargains that are in boring businesses (ugly), with uncertain prospects (complex), that rarely disclose anything to investors (opaque). Sound familiar?

The reason I gave the above example about Integratas was not because I think its a particularly compelling investment. But I do think an investor would be better spent learning the securities industry in the tri-state area than spending time reading Microsoft's 10K where they will compete with legions of investors. I bet you no more than 10 people knew about the Integratas acquisition before this post. Let's say you can eek 5% margins on the $7M of revenue or 350k of EBITDA. Versus a purchase price of 750k (and only 250k due up front), that doesn't look like a terrible investment at all.

I could read bankruptcy cases all day long. That may be a sick sick thing to say but the stories of these companies are simply riveting. And because I have done this for some times, the opacity begins to melt away, and the trove of information is incredible. Some information released on dockets would scare public companies. But with that information, an astute investor can, in my opinion, get closer to the intrinsic value of an enterprise.

Sometimes its hard to invest in these enterprises. Trade claim shops probably do it best by sourcing their own claims by "dialing for dollars" (i.e. calling listed creditors and offering a % of par for their claim). Though that can be administratively expensive unless you are dolling out 5 figures a purchase and you do not have your ducks in a row.

Author Note: I do not know the distressed private equity industry as well as I should. Lynn Tilton's Patriarch Partners is one that you hear about most often. I'd be curious if readers had any other names I should get to know that participate in companies with EV's less than $50M that play across the capital structure in loan to own strategies. Please shoot me an email with suggestions.

With the markets currently in a bit of "shaky patch" and most distressed debt guys I know reading everything they can about CAPP coal and legacy liabilities (see: PCX), it is starting to get more fun and interesting out there.  New issue concessions are definitely high and the bull trade / thesis rests on an ECB or Bernake put. We are still no where close to time to drain the penny bank into the market, but it feels a lot more fairly valued to a whisper of cheap, out there. There still isn't a lot of pain though or really panic as the sell offs have seem orderly.

I am very very lucky to have been exposed to a part of the market that few experience early in my career. People ask me "How do I get involved in distressed?" Start with A. Find a case in a local district of yours and follow the proceedings closely. Call some of the creditors and see if they will part with their claims. Talk to the lawyers and get to know some of the players involved in the space. Head to the court and sit in on a proceeding. By doing this with one or two cases, you'll learn more than you ever sitting in a class. And maybe, just maybe, you'll find an opportunity that you can plow significant capital into and come out with out-sized gains because you were the only one in the world paying attention.


U.S. Supreme Court Affirms Right of Secured Lender to Credit Bid Under a Chapter 11 Plan

As we first discussed a few weeks ago, the Supreme Court of the United States heard arguments related to the legitimacy of the practice known as credit bidding. The decision was important as credit bidding is a fundamental tenet of distressed debt investing under loan to own strategies. Contributor George Mesires weighs in on the issue:

On May 29, 2012, the Supreme Court decidedly put to rest an issue that has caused secured lenders angst since 2009 when the Fifth Circuit in the Pacific Lumber case first allowed a debtor to sell assets under a plan of reorganization free and clear of a creditor’s lien without providing that lender the right to credit bid its debt in the sale. Specifically, the Court settled the split among the judicial circuits (the Seventh Circuit on the one hand, and the Third Circuit (home to the Delaware bankruptcy court) and the Fifth Circuit, on the other) by holding that a debtor “may not obtain confirmation of a Chapter 11 cramdown plan that provides for the sale of collateral free and clear of [a secured lender’s] lien, but does not permit the [secured lender] to credit-bid at the sale.”  The decision provides needed guidance to secured lenders and practitioners as the previously unsettled state of the law added uncertainty, risk and a higher cost of capital in these credit bid situations.

Generally, a debtor in bankruptcy may sell its assets in two ways: (i) under § 363 of the Bankruptcy Code; or (ii) pursuant to a plan of reorganization under § 1123 of the Bankruptcy Code.

Under § 363, it is not disputed that a secured creditor may credit bid its debt (unless the court in very limited circumstances finds that “cause” exists to deny the secured lender the right to do so).

Alternatively, a debtor can sell its assets pursuant to a plan of reorganization. In certain circumstances, a debtor can “cramdown” a plan of reorganization over the objection of creditors, including a secured creditor. To cramdown a secured creditor, among other things, the reorganization plan must be “fair and equitable” to the secured creditor. The “fair and equitable” standard may be satisfied by showing that the plan provides: (1) that the holders of such claims retain the liens securing such claims and receive deferred cash payments having a present value equal to the value of their collateral; (2) for the sale of the collateral free and clear of liens (with such lien attaching to the sale proceeds of the sale) but subject to the secured creditor’s right to credit bid; or (3) for the realization of the secured creditor’s claim by some means which provides the secured creditor with the “indubitable equivalent” of its claim.

Thus, the plain language of clause (2) above states that a secured creditor shall have the right to credit bid in a sale of its collateral pursuant to a plan of reorganization.  Indeed, historically, there has been little dispute that a secured lender had the right to credit bid its debt in such cases.  Recently, however, several creative debtors (see e.g., debtors in the Pacific Lumber, Philadelphia Newspapers, and RadLAX cases) have attempted to sell a secured creditor’s collateral pursuant to a plan of reorganization without allowing the creditor to credit bid.  Such arrangements have been upheld by two federal circuit courts (the Third and Fifth Circuits), and disallowed by another (the Seventh Circuit).  

In the RadLAX case, the debtors proposed selling substantially all of their assets under a plan of reorganization and using the sale proceeds to repay the secured lender. As part of its plan, however, the debtors sought to deny the lender the ability to credit bid its debt.  Not surprisingly, the bank objected to such treatment, since the bank would be forced to come out of pocket with cash, which adds both administrative and financing costs to the transaction, instead of using the debt owed to it as currency.

It was fitting that Justice Scalia, one of the Court’s great textualists, delivered the 8-0 opinion for the Court.  Calling the debtors’ reading of § 1129 “hyperliteral and contrary to common sense,” Justice Scalia did away with a detailed analysis of the purposes of the Bankruptcy Code, pre-Code practices and the merits of credit-bidding that lower courts focused on, and instead focused on a well established canon of statutory interpretation – the general/specific canon.  That principle of statutory interpretation provides that “specific governs the general” and where a general authorization and a more limited, specific authorization exists side-by-side, the terms of the specific authorization must be complied with.  Thus, “clause [2] of the fair and equitable standard (above)] is a detailed provision that spells out the requirements for selling collateral free of liens, while clause [3] is a broadly worded provision that says nothing about such a sale.  The general/specific canon explains that the ‘general language’ of clause [3], ‘although broad enough to include it, will not be held to apply to a matter specifically dealt with’ in clause [2].”

Justice Scalia, in a nod to the United States Department of Justice, who filed an amicus curiae brief supporting the secured lender’s position, acknowledged in a footnote that the right to credit bid is “particularly important for the Federal Government, which is frequently a secured creditor in bankruptcy and which often lacks appropriations authority to throw good money after bad in a cash-only bankruptcy auction.”

The Supreme Court’s ruling is important for at least two reasons.  First, resolution of this issue will streamline the administration of future bankruptcy cases by providing secured lenders the assurance that they can credit bid in both 363 and plan sales under the Bankruptcy Code, which will result in greater efficiency and lower costs of capital.

Second, the Court’s decision upholds the long-standing principle that bankruptcy law has not permitted a secured creditor to lose its lien in bankruptcy without the lender’s consent, payment in full, or surrender of the collateral to the lender.

George is a monthly contributor to the Distressed Debt Investing blog and practices restructuring and bankruptcy law at Ungaretti & Harris LLP.  George can be reached at grmesires@uhlaw.com.  



My Favorite Ideas from Ira Sohn

Last week we attended the Ira Sohn Research Conference where some of the best hedge fund managers in the world pitched some amazing investment ideas. For those that were not following, I was updating readers in real time on Twitter (@DDInvesting) trying to get information out as fast as humanly possibly.

In that regard, our notes from this year our going to take a different feel. For more comprehensive notes you can visit Jay at Marketfolly or Jacob at ValueWalk or Josh at The Reformed Broker. In addition, a number of the presentations are being floated around specifically Bill Ackman's presentation on JCP.

In terms of distressed debt portfolio managers, the panel of speakers included notable player Jonathan Kolatch, founder of Redwood Capital, who was very impressive. In fact I believe, and I might be mistaken, Kolatch used to work with Dave Tepper at Goldman Sachs (forgive me if I have that fixed up). Larry Robbin's Glenview Capital and John Paulson are also active players in the distressed debt market. It was great to hear from each of them.

So for each manager, I have boiled down the ONE take-away I came away with from the conference. Some of these are investment ideas and some are more general investing wisdom.  Overall I encourage all of you who have never been to the conference to attend one soon - it is such a learning experience listening to best pitch their ideas. Enjoy!

Ken Rogoff - Harvard University

Professor Rogoff spoke about what he is known best for: severe finance crisis. His book "The Time is Different" talks about, in depth, many of the great financial calamities world economies have faced in the past. The most interesting or salient point he made: Looking at the charts, Greece has been in default for 50% of the years since the data was recorded. The situation in Greece (as well as other weaker European nations) is keeping a tight lid on the euro which is beneficial to German consumers and industry. If this dynamic wasn't the case, I think the fact that the country you are trying to save has been in default 50% of the time, you have to let it go.

Larry Robbins - Glenview Capital Management

I interviewed at Glenview many moons ago when their AUM was 1/5 of what it is today. I regret not closing that position because Robbins is simply a force of investment acumen. Robbins spent most of his time talking two trades: Long hospitals and life sciences (Tenet in particular) and short the "new high club" - treasuries, utilities (specifically ITC) and the defense sector. The takeaway from this presentation was simply the thoroughness of the ITC short. Glenview went as far as testifying in front of the regulators that ITC's capital structure allowed it to overcharge consumers. The short wasn't really valuation in nature (in my opinion the worst kind of shorts). It was based on technical information that required a lot of digging. And there is a catalyst here - a rate review / drop in rates so the shorts just don't have to sit around forever and wait for valuation to come down.

Jonathan Kolatch - Redwood

Kolatch spent his time discussing Argentina sovereign debt. He compared Argentina to other countries in Europe: Debt to GDP is half or less than most countries in Europe. There are less deficits. Rapid GDP growth. And bonds yield 15% - well higher that most countries.  It was a very compelling presentation. Kolatch noted that if Argentina traded 300 bps behind Brazil, the trade offered a 36.5% IRR (in 3 years) with a 13.7% current yield. The takeaway here is summarized by how Kolatch described Argentina's nationalization of YPF. He agrees that its a bad thing, but the motivations might be different from what the market is handicapping and that creates opportunities and mispricings.

Dwight Anderson - Ospraie Management

This is the first time I've heard Tutor and Tiger Alumni Dwight Anderson speak. Anderson's talk focused on two ideas: Long Westlake Chemical, and a pair trade of long palladium / short platinum. The takeaway here, and similar to other Tiger alumni, is the understanding or better yet anticipation on what's going to happen next. The second-derivative thinking on Westlake was a beautiful thing to watch: Low nat gas prices are a benefit to Westlake and the benefit is no where close to being fully realized. Similarly the platinum vs palladium trade was thinking two steps ahead: Platinum mine production is accelerating later this year into net year, whereas palladium will be in a deficit, combined with structural changes in the consumption of the two materials in auto products. Really compelling stuff.

Meryl Witmer - Eagle Capital 

Witmer learned the ropes with Michael Price and Max Heine of Mutual Series. She spent her time talking about two idea: Gildan and Viacom. In one of her opening slides, she discussed Eagle's general philosophy which focus on looking for strong management teams that are good capital allocators who buy back stock a "fire sale prices" running companies that generate good cash flow and maintain a healthy balance sheet. The emphasis on fire sale prices is interesting - so often the investment community pushes for companies to buy back stock irrespective of price. Yes, its probably better than making a dumb acquisition, but its far less important the value of cash in a downturn (whether buying own stock or someone elses). As investors we know this but we rarely put that to our management teams we cover.

Phillipe Laffont - Coatue

Lafont spoke about two stocks: Equinix and Virgin Media. Similar to other Tiger Cubs, Laffont looks for industry leaders. One of the most interesting things he said at the conference, which I had never really thought about: The market inappropriately values companies that will do a LARGE forward buyback. So a company like Virgin Media which in theory could buy back all its shares outstanding in the next five years is seriously undervalued. He didn't postulate why this is - it's probably because many market participants simply don't believe management.

John Wilder - BlueScape Resources

This was an amazing presentation on the dynamics going on in the natural gas market. One of the industries I have never covered is oil/gas, but I do look at the coal names (moreso now than a few weeks ago) which is relevant in so many ways.  Wilder was quite bearish on the near term forward curve for gas.  The one key point I took away from his presentation was a fantastic graph showing commodity prices versus GDP - natural gas demand has been relatively stable / flat and has not kept up with GDP growth. With little gas drilling economically viable at current pricing (outside the Marcellus) the demand side wildcard of LNG exports may not be all they are cooked up to be - the mystical "100 BCF/day won't happen in the near term.

Jeffery Gundlach - DoubleLine

The introduction to Gundlach noted that according to one study, DoubleLine is the fastest growing company in America. That is magical. I have covered Gundlach on the blog a number of times. If you haven't heard him speak, you are missing out. Gundlach talked about constructing portfolio that can handle all tail scenarios. To Gundlach, cooperation = bull market; contention = bear market - and we have a ton of contention right now. I listed his trades on Twitter, but for those not there: Long IBEX, 1 year Libor (10x levered), natural gas, cash; Short SPX, JWN, Apple, 2 year swaps. The portfolio he laid out makes a lot of sense and in a very bullish or very weak market, would probably do well.

David Einhorn - Greenlight Capital

This was a whirlwind presentation. You can see part of it here: Greenlight's Thoughts on Cash Heavy Companies. The amount of items covered here would be impossible to do any service to, on either the long or the short side. Probably one of the better ideas presented here was short Dicks Sporting goods on encroachment from Amazon. Again, 2nd order thinking here (which really was present throughout the presentation: US Steel short, Japan, Cairn Energy, etc).

Dan Ariely - Duke University

Dan Ariely is one of the leading experts in behavioral economics and self-control. His talk really centered on the latter. Ariely pointed out that self control, boiled down, is the dynamic between long term interests and short term interests: And the short term usually wins. As such, how do we overcome this? The take-away here is how loss aversion can affect us outside of investing. Studies show we have to win 2-3x what we equivalently lose to have the same emotional effect on ourselves. So instead of using "treats" to reward ourselves, instead use the loss of "treats." His example: When he told diabetic patients he'd give them $3 each day they took their meds, no one changed their habit. When he then told another group of patients that he deposited $100 in their bank and that each time they didn't take their meds, he'd take $3 out, there was an 80% increase in compliant patients. Amazing! The last point he made was really telling: Self control problems will only get worse in times; marketers will not make their products LESS tempting.

Steve Mandel - Lone Pine

Another Tiger Cub. And similarly he said: I believe leaders stay leaders and leaders win. His themes include being negative on fixed income, being long tech leaders, and being long share count shrinkers. The one name he mentioned was Kohl's which trades below 10x, has been affected by cotton prices (short term problem) and has a solid leadership team aggressively buying back stock at a discount to intrinsic value.

John Paulson - Paulson & Co

John Paulson likes to think big. And as I noted, his CVI trade was probably the best idea presented (despite the fact that you had to buy it at T+2 or T+1 to actually execute the trade). His thesis on CZR brought some interesting facts to life - i.e. the holding company owns assets (online gaming) outside of the levered enterprises and you're probably already covered there. He did note that CZR was an option play and placed a $138/price target on the name. He also spoke about AngloGold Ashanti, which in his opinion, is the cheapest way to play gold.

John Lykouretzos - Hoplite

Another Tiger Cub (Tiger Cub Cub - was a PM at Viking). This is the first time I have heard Lykouretzos speak. He presented on Starbucks and laid out a very very compelling thesis. Again Tiger Cubs like to play quality companies and really Starbucks is one of the best out there.  He laid out a number of tenets of value and pointed out that growth in the U.S. store base + moving to consumer packaged goods could create tremendous shareholder value.

Bill Ackman - Pershing Square

On a day JCP was getting absolutely murdered, Ackman, as usual presented a detailed case study on why he is long JCP (and the next day his slate of directors was elected at CP). I do not want to do the presentation any disservice, so I'll link to it for those that have not seen it. The title is Think Big - and at the end he notes JCP could be worth $300/share. Thing big we shall! Here's the presentation.



Competing Plans in Bankruptcy

Over the last few years, we've seen a number of cases run parallel plans in bankruptcy - sometimes contentiously between creditors trying to argue they are the fulcrum and sometimes for legitimate business reasons. Distressed Debt Investing contributor George Mesires of Ungaretti & Harris LLP has written a piece talking about competing plans in bankruptcy. Enjoy!

Competing Plans in Bankruptcy
One of a debtor’s most powerful levers during a bankruptcy case is its exclusive right to file a plan of reorganization during the first 120 days of a bankruptcy case.  This period, commonly known as the exclusivity period, coupled with the automatic stay, provides a debtor breathing room to focus its efforts on, among other things, formulating a plan of reorganization to exit bankruptcy.  Exclusivity provides a debtor an opportunity to develop its plan of reorganization without the threat of its strategy immediately being derailed by competing constituents.  Certainly the careful debtor may work with other constituents to build consensus around its plan of reorganization, but exclusivity gives a debtor the initial leverage over its creditors and other constituents during the important early few months of a bankruptcy case.

Often times, however, particularly in complex bankruptcy cases, 120 days is simply not enough time for a debtor to formulate its plan of reorganization, and in such circumstances, debtors often request, and courts routinely grant, extensions of the exclusivity period.  Indeed, in many cases, debtors were granted seemingly indefinite extensions, a practice that led some critics to contend that exclusivity extensions unduly prolonged the time and increased the expense of chapter 11 reorganizations to the detriment of other constituencies.  Even though the Bankruptcy Code permitted a party in interest to petition the bankruptcy court for authority to file a competing plan, such requests were rarely granted.  Generally, if a bankruptcy case appeared to be on-track, courts deferred to the debtor so that the debtor could maintain control of the plan process.

To address the concern that debtors were hiding behind the cloak of exclusivity to the detriment of other constituents, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) amended the Bankruptcy Code provision relating to exclusivity by imposing an 18 month limit on a debtor’s exclusivity period.  The amendment was intended to motivate a debtor and other constituents to develop a consensual plan, thereby reducing the time and expense of a protracted chapter 11 proceeding.  Notwithstanding its laudable intent, the BAPCPA amendment relating to exclusivity may have, in fact, complicated the chapter 11 process by stripping bankruptcy courts of their discretion to extend exclusivity and automatically permitting other constituents to file competing plans after 18 months.

The Exclusivity Period
Pursuant to § 1121(b) of the Bankruptcy Code, a debtor has the exclusive right to file a plan of reorganization during the first 120 days after the commencement of a chapter 11 case.  If a debtor files a plan during this exclusive filing period, section 1121(c)(3) of the Bankruptcy Code grants an additional 60 days during which the debtor may solicit acceptances of that plan, and no other party in interest may file a competing plan.

Section 1121(d) of the Bankruptcy Code provides that the Court may, in its discretion, “for cause,” extend these periods: “[o]n request of a party in interest . . . and after notice and a hearing, the court may for cause reduce or increase the 120-day period or the 180-day period referred to in this section.”  11 U.S.C. § 1121(d)(1).

Although the Bankruptcy Code does not define “cause,” a number of courts have looked to the Bankruptcy Code’s underlying legislative history for assistance in construing this term in this context.  See, e.g., In re Ravenna Indus., Inc., 20 B.R. 886, 889 (Bankr. N.D. Ohio 1982); accord In re Amko Plastics, Inc., 197 B.R. 74, 77 (Bankr. S.D. Ohio 1996); Gaines v. Perkins (In re Perkins), 71 B.R. 294, 297-98 (W.D. Tenn. 1987); Teachers Ins. and Annuity Ass’n of Am. v. Lake in the Woods (In re Lake in the Woods), 10 B.R. 338, 342-45 (E.D. Mich. 1981).

Courts hold that the decision to extend the exclusivity period is left to the sound discretion of a bankruptcy court and should be based on the totality of circumstances in each case.  See, e.g., 203 North LaSalle Street P’ship v. Bank of Am. Nat’l Ass’n (In re 203 North LaSalle Street P’ship), Nos. 99 C 7110 and 99 C 7108, 1999 1206619 at *4 (N.D. Ill. Dec. 13, 1999) (“[T]he Code commits the decision on extending the exclusivity period to the discretion of the bankruptcy court.”); First Am. Bank of N.Y. v. Southwest Gloves & Safety Equip., Inc., 64 B.R. 963, 965 (D. Del. 1986); In re Dow Corning Corp., 208 B.R. 661, 664 (Bankr. E.D. Mich. 1997); In re McLean Indus., Inc., 87 B.R. 830, 834 (Bankr. S.D.N.Y. 1987).

In determining whether cause exists for an extension of a debtor’s exclusivity period, courts have relied on a variety of factors, each of which alone may constitute sufficient grounds for extending the exclusivity period.  Factors that courts have routinely considered to determine whether “cause” exists include: (a) the existence of good faith progress towards reorganization; (b) the size and complexity of the debtor’s case; (c) a finding that the debtor is not seeking to extend exclusivity to pressure creditors to accede to the debtor’s reorganization demands; (d) existence of an unresolved contingency; and (e) the fact that the debtor is paying its bills as they come due.  However, in no event shall the exclusivity period be “be extended beyond a date that is 18 months after the [petition] date,” and the 180-day period “may not be extended beyond a date that is 20 months after the [petition] date.” 11 U.S.C. § 1121(d)(2).

BAPCPA Amendment Concerning Exclusivity
Following the BAPCPA amendment to § 1121, regardless of how well the bankruptcy case is progressing, bankruptcy courts no longer have any discretion to consider requests for an extension of exclusivity beyond 18 months after the petition date.  Accordingly, after 18 months, any party in interest has the ability to file a competing plan of reorganization.  The sudden ability of other parties in interest to file a plan of reorganization can have a dramatic effect on the negotiating posture of the competing constituents and significantly alter their negotiating leverage.  Moreover, competing plans will likely add further complexity (both procedural and substantive) to the proceedings.

The Tribune bankruptcy case is probably the most prominent example of a post-BAPCPA case that became significantly more complex and protracted following the expiration of the debtors’ exclusivity period.  Following the automatic expiration of exclusivity in August 2010, and efforts by a mediator to garner support for a single plan, four plans of reorganization were filed by various creditor groups.  And nearly two years after the expiration of exclusivity, Tribune is still in bankruptcy.  (Yet to be fair, confirmation hearings are set for next month).  See also, Lehman Brothers (three competing plans); Tronox (two competing plans); Meruelo Maddux Properties (three competing plans).  All of these cases posed significant procedural challenges after the competing plans were filed, mainly because the Bankruptcy Code is silent as to how competing plans should be presented to the creditor body.  Should competing plans be presented to voters simultaneously or sequentially?  What processes should govern dissemination of the vast amounts of information associated with competing plans?

Regardless of the outcome of these cases, one question that will remain unanswered is whether such cases would have been more efficiently administered had the bankruptcy court retained the discretion to extend the debtor’s exclusivity period, or whether amended § 1121 compounded the cost and length of the bankruptcy proceedings.

George is a monthly contributor to the Distressed Debt Investing blog and practices restructuring and bankruptcy law at Ungaretti & Harris LLP.  George can be reached at grmesires@uhlaw.com.



TOUSA Two-Step Ruled Fraudulent Conveyance by 11th Circuit Court of Appeals

Before we get to the post: Ira Sohn thoughts/commentary will be posted over the weekend. In the meantime, Jay at MarketFolly has a comprehensive set of notes up. I wrote this on my Twitter feed: John Paulson's idea of the CVI contingent value securities was the most compelling - I'm still doing my research on it. Behind that was Bill Ackman's thesis on JCP: First time I've heard it and I get the premise of the pitch. I am long JCP stock as of yesterday.

To more relevant, distressed business. Contributor Josh Nahas, Principal of Wolf Capital Advisors, and I were speaking today. Earlier this week, the TOUSA decision was overturned by the appellate court. Aurelius, one of the best distressed funds around, benefited greatly on this ruling. This could be one of the more salient stories in distressed debt land this year and no one out there is as good in covering these situations like Josh. Enjoy!

TOUSA Two-Step Ruled Fraudulent Conveyance by 11th Circuit Court of Appeals

On May 15, 2012 The United States Court of Appeals for the Eleventh Circuit reversed the decision of Judge Alan S. Gold of the U.S. District Court for the Southern District of Florida in the Bankruptcy of homebuilder TOUSA Inc. The Circuit court upheld the previous ruling by the Bankruptcy Court that in fact the financing of the payment to Transeastern Lenders constituted a fraudulent conveyance. The issues in the case have has been closely followed by bankruptcy attorneys, secured lenders and distressed investors as the implications are far reaching, particularly as it relates to rescue financing for companies near insolvency. Link to ruling: http://react.bracewellgiuliani.com/reaction/documents/BasisPointsTousa11thCircuitOpinion.pdf

Not only did the Circuit court uphold the Bankruptcy Court’s finding that a fraudulent conveyance had occurred, but it also found that the Transeatern Lenders were repaid by the proceeds of that fraudulent conveyance and were subject to potential claw back litigation as “initial transferees”. In addition, the court found  that the Transeatern Lenders bore some responsibility for diligencing the source of funds that was being used to repay them, and therefore should have known that their repayment was likely the result of a fraudulent transfer.

The distressed community has been split on the issues in TOUSA with most willing to acknowledge that the 2007 financing was highly suspect, while uncomfortable with idea that lenders should be held responsible for diligencing the sources of their repayment.  Funds specializing in rescue financing and secured lending, as well as distressed funds who were in the Transeatern Loan, were the most disturbed by the ruling; while distressed investors, and certainly TOUSA’s unsecured bondholders, felt that a line was finally being drawn over perceived corporate maneuvering and asset shuffling prior to a Chapter 11 filing.

As a quick refresh for our readers (see earlier post for more details) TOUSA was a Florida based homebuilder focused on the construction of single-family residences as well as townhomes and condominiums.  TOUSA Inc and its subsidiary TOUSA Homes LP had also entered into a JV with Falcone/Ritchie LLC (Transeastern) that was funded by the group of creditors referred to by the court as the “Transeastern Lenders”.  However, when the housing market began to turn down, the JV failed.

As a result TOUSA wound up in litigation with lenders to the JV and ultimately agreed to a $420mm settlement.  In order to pay for the settlement TOUSA raised a new first and second lien term loan facility.  The loan was secured by essentially all of TOUSA’s unencumbered assets including its previously unencumbered subsidiaries, the “Conveying subsidiaries” (the subsidiaries were guarantors on the $700mm revolver).  In January 2008, approximately six months after the closing of the new loan, TOUSA and its subsidiaries filed for Chapter 11 Bankruptcy protection. (1)

The Unsecured Creditors Committee (“UCC”) sought to have the new loan avoided as a fraudulent conveyance on behalf of the debtors’ estate and the proceeds paid out to the Transeastern Lenders returned for the benefit of the unsecured creditors.  The UCC argued that the Conveying Subsidiaries had not received reasonably equivalent value in exchange for securing the new credit facilities.  The unsecured creditors filed litigation to recover the value of said liens from the Transeastern Lenders under section 550(a)(1) of the Bankruptcy Code on the ground that the Transeastern Lenders were the entities to whose benefit the liens had been granted. (2)

Judge John K. Olson of the Bankruptcy Court for the Southern District of Florida agreed with the claims asserted by the unsecured creditors and found that a fraudulent conveyance had indeed occurred.  As part of his decision Judge Olson relied heavily on the evidence from the public domain regarding the condition of the housing market, TOUSA’s sagging stock price as well as the public comments of TOUSA executives regarding a potential restructuring that demonstrated the company’s precarious financial situation and called into question the solvency of the debtor prior to the 2007 refinancing.

On appeal Judge Gold heavily criticized the Bankruptcy Court’s reasoning and its reliance on anecdotal evidence and took the unusual step of quashing the bankruptcy courts ruling.  Judge Gold found that the Transeatern Lenders had no duty to conduct what he deemed “extraordinary due diligence” and that the Conveying Subsidiaries received reasonably equivalent value.  This value was almost entirely attributed to TOUSA avoiding bankruptcy as a result of the Transeatern Lenders being repaid and thus averting a a Chapter 11 filing..

The 11th Circuit disagreed with Judge Gold’s finding and held  that a fraudulent transfer had taken place and that lenders should have a duty to conduct some level of due diligence as to the source of their repayment, particularly when the entity is in financial difficulty.  While the Circuit court did not address specifically whether reasonably equivalent value was received by the Conveying Subsidiaries and affirmed that avoiding bankruptcy is a source of value, the court found in favor of the Bankruptcy Court’s ruling that the risk assumed by the Conveying Subsidiaries far outweighed the perceived benefits of avoiding bankruptcy.

The Circuit court also addressed the question of whether the Transeatern Lenders constituted initial transferees under section 550(a)(1)  of the Bankruptcy Code subject to a clawback of funds as a “subsequent transferee” under section 550(b)(1) which provides for good faith defense against litigation seeking the recovery of funds.  Ultimately the court ruled that the Transeastern Lenders met the definition of initial transferees which will likely make them subject to recovery actions by the UCC. The Court has now remanded the case back to the District court to determine what the appropriate remedies should be given that a fraudulent transfer has been ruled to have occurred.(3)

It appears that the Court is not looking to impose unrealistic expectations on all future lenders, nor is it questioning the value attributable to avoiding restructuring.  Rather, they seem to be focused on the facts in TOUSA which appear to be particularly egregious and therefore should not be considered standard. Indeed, the Court’s analogy to TOUSA’s demise being more akin to a “slow-moving category 5 hurricane than an unforeseen tsunami.” seems to indicate that debtors will still be able to exercise their best judgment and pre-petition rescue lenders will not routinely be found liable for fraudulent conveyance, despite what opponents to the Bankruptcy Court’s ruling feared it would imply.  However, debtors, lenders and their advisors will likely now be more cautious in situations where they are operating near the zone of insolvency.

Given that many distressed investors participate in rescue financing as well as in distressed loans that they believe may be refinanced, there are reasons to be concerned about a ruling that requires investors to diligence the source of funds being used to repay them.  Nevertheless, distressed investors routinely find themselves in situations where they feel the debtor is given far too much leeway to maneuver its assets and engage in rescue financing when an orderly restructuring is in the best interests of creditors and is likely inevitable.

The courts both in and out of bankruptcy already provide the debtor with broad latitude in their financial decisions as per the business judgment rule and efforts by distressed investors to negotiate a consensual restructuring are frequently stymied as a result.  Dynegy is a good analog for the TOUSA situation and most distressed investors (and the court appointed examiner) would agree that the kind of maneuvering that occurred in that case was disturbing and should be prevented from occurring in the future.

Finally, while potential fraudulent conveyance litigation is not usually the primary driver behind an investment thesis, it is a valuable chip in the negotiations with the debtor and the pre-petition lenders.  Had the district court’s ruling stood, distressed investors would have faced an almost insurmountable hurdle in proving a fraudulent conveyance had occurred, and would have lost a valuable leverage point in negotiating with the debtor.  Moreover, it would have likely emboldened debtors and their advisors to engage in even more pre-petition maneuvering rather than pursue a meaningful restructuring.  Too often creditor value is eroded while management of financially distressed companies pursue unrealistic plans to avoid the inevitable restructuring.

Net/Net while the ruling has some potential negative effects for distressed investors focused on rescue lending or when betting on a distressed piece of paper being refinanced, the ruling itself will likely be a positive for distressed investors. Hopefully it will encourage debtors to engage its creditors in meaningful dialog prior to filing a Chapter 11 and avoid some of the more questionable transactions such as TOUSA, Dynegy and Tribune.

(1) Judicial Backlash Adds to Challenges Faced by Lenders.  Edward Estrada, Reed Smith.  The Journal Of Corporate Renewal, July/August 2010
(2) Eleventh Circuit Upholds Bankruptcy Court’s Fraudulent Transfer Ruling in TOUSA  Debra Dandeneau. Weil Bankruptcy Blog, MAY 16, 2012 http://business-finance-restructuring.weil.com/fraudulent-transfers/eleventh-circuit-upholds-bankruptcy-courts-fraudulent-transfer-ruling-in-tousa/#axzz1vANZnoP5



Distressed Debt: Rescap

Yesterday, May 14th, 2012, Rescap filed for bankruptcy in the Southern District of New York (Case No. 12-12020). The Honorable Judge Martin Glenn will be overseeing the proceedings. Currently the markets on Rescap look like this:

  • Recovery: 22-23.5
  • CDS: 76.5-77.5
  • 9.625% Bonds: 95-96
  • Senior Unsecured Bonds: 22-24
For those interested in tracking the docket, you can find it here:

Rescap has been a name debated and discussed in distressed circles for as long as I can remember. I remember investment banks talking about it at their distressed conferences before the crisis. It has an interesting history that we will get to shortly. The good ole days when GMAC was called GMAC.

Rescap is the 5th largest servicer of residential mortgage loans in the United States behind the likes of BofA, JPM, Wells, and CitiMortgage. Rescap and non debtor but affiliated Ally (AFI) are the 10th largest originator or mortgages in the country. The bankruptcy plans lays it out pretty clearly: They will be selling down the assets and the assets they cannot sell will be run-off/wound down over time. 

The corporate structure chart here is simply fantastic. It spans 6 pages which I've reproduced, into one Frankenstein sort of job with my MS Paint skills:

Exhibit 7 in the First Day Affidavit shows the history of Rescap and Ally Financial, now 74% owned by the U.S. government, from 2007 until the petition date. Its a fascinating read. Interesting fact: "Since January 1, 2007, AFI has made capital contributions of approximately $10.3 billion to ResCap."

For those that have not seen the Houlihan Valuation here are the salient components.  First the assets that are pledged to the Ally Secured Facility the the Junior Secured Notes:

And the waterfall with footprints in text below:

The takeaway: According to this analysis, Total recovery to the 3rd lien notes is 105% with 12 points coming from an unsecured deficiency claim which is based on an assumption of:
  • $600M admin and priority claims
  • $9B of contingent liability claims (reps and warranties) -> Higher than the market was thinking
  • $1.4B of other general unsecured claims
Bloomberg reports that noteholders of the the 3rd lien include Paulson & Co and Appaloosa Management. It has also been reported that Berkshire owns a substantial amount of Rescap debt across the structure and over the past few years, many reports have surfaced that Berkshire was interested in purchasing parts (or possibly all) of ResCap.  

On the Ally conference call today, Ally CEO Michael Carpenter stated:
In addition, ResCap entered into a comprehensive settlement agreement between Ally and ResCap that is subject to confirmation by the bankruptcy court. I'll get into it in a bit more detail in a minute, but importantly it contains provisions to release Ally both from theoretical claims from ResCap and third-party claims. 
For years people have been talking about the ability for Rescap to bring down Ally (in fact the GMAC ring fence originially was designed to protect Rescap from GMAC believe it or not).  Carpenter goes on to say:
The settlement agreement, which is subject to court approval, what it provides for Ally is first of all, the release of all claims between Ally and ResCap. Let me touch on that for a minute. Those of you who've heard me talk about two or three times have heard me repeatedly say, Ally and ResCap are two separate companies. 
And ResCap's separability is ensured by the fact that historically it's been an SEC registrant, and the disclosures associated with that, but it has the Board of Directors with independent member. There are operating agreements that the various contractual contracts between, having to do with the servicing business are clearly contracts with ResCap not with Ally. And for all these and many other reasons, we believe that the liabilities of ResCap do not penetrate to Ally.
A number of questions followed on the legacy liability issues and how it relates to Ally. 

What I think you'll see here is the unsecured bonds continue to leak after technical with the CDS auction and funds unwinding their basis packages (long protection, long cash) correct themselves and then you'll get litigation focused funds coming in (if they already not have) and trying to buy as many bonds as possible in a Tribune like trade. Think the argument goes, Rescap sold Ally these assets:
  • Health Care Finance Business
  • Resort Finance Business
  • Canadian Lending Operation
  • IB Finance
  • US and UK broker-deal operations
And Cerberus these assets:
  • Model Home Finance Business
  • Securities backed from Freddie / Fannie
as well as its ownership of Ally Bank moving to AFI.  And in exchange it didn't get reasonably equivalent value. The look back period might be the only thing saving AFI here. I remember quite often the term coercive exchange being thrown around as well which can't really help anyone's case.

Let's think about the incentives here: Ally wants to do its IPO for various reasons. US Gov't wants to get paid back. Minority equity holders want liquidity. Management is probably getting a bonus if they do it. The discovery process to investigate these claims going back a number of years will take lots and lots and lots of time and money.  And given that that class is ~$1 billion a 10 point tip would only be $100M relative to Ally's balance sheet which is many many times larger. 

The unsecured bonds here have always been illiquid with legacy holders that did not participate in the coervice exchanges as well as basis package players. The bonds traded at 50 +/- 10 points at the beginning of the year.  At 10 point tip there is only a 20% boost. A 10 point tip on a bond priced in the teens / 20 is much more appealing. In addition, you have the optionality in the reps and warranties claim coming in markedly lower than being forecasted today.  

I've been asking around to see if any of the unsecured bond holders have started organizing or talking; if you hear anything, let me know. 



2012 Ira Sohn: Follow us on Twitter for Real Time Updates

We want to give readers an update on our post last week on the 2012 Ira Sohn Conference.  The conference is tomorrow and there is still time to register.  This is an amazing cause. I hope you all consider attending. Here is the link to the conference registration.

A quick update: Distressed Debt Investing will be at the Ira Sohn Conference tomorrow taking diligent notes which we will post later in the week. If you want to follow us real time, we will be on Twitter, where I will be posting live updates on recommendations by the fantastic group of speakers.

Follow us: @DDInvesting



Lightsquared Files for Bankruptcy

Editor Note: I will be writing a post on Ally / Rescap tomorrow, Tuesday the 15th after the Ally call. At the end of the day, the 3rd lien 9.625% went out 94-95, down 4-5 points. I will also be writing a post this week, in a new template, for Houghton Mifflin.

Today, LightSquared Inc. ("LightSquared" or "the Company") and 19 of its subsidiaries filed for bankruptcy in the Southern District of New York (12-12080). As most are aware, LightSquared is the spectrum play of Phil Falcone's Harbinger Capital, which recently represented a large portion of Harbinger's assets.

For those interested, the docket (via the claims agent site) can be found here: LightSquared Docket. The Term Loan went out 67-68.5 (flat) at the end of the day. The bank debt has rallied as of late on news reports that Charles Ergen, owner of DISH Network, had purchased a substantial amount of bank debt in the name.

Some interesting points of reference from the First Day Declaration of CFO Marc Montagner:

  • From 2001 to today, LightSquared has invested approximately $4 billion of funds in its wireless network business plan (4G LTE open wireless broadband network)
  • Significant discussion of working with GPS industry and the subsequent issues with interference (that has also widely been reported in the press): "As it had done in all previous situations, LightSquared offered to work with the various governmental agencies and the GPS industry to rectify these issues and to expend significant resources in aid thereof. Unlike all previous situations, however, the GPS industry refused to compromise with LightSquared and instead sought to convince regulatory agencies to strip LightSquared of its ability to use its allocated spectrum for terrestrial purposes"
  • All parties, including LightSquared are awaiting an FCC decision, after a public comment period, for LightSquared's ability to use its spectrum for terrestrial purposes
  • LightSquared has cut 1/2 of its employees and reduced burn by 30%
  • Looks like there was an attempt at an out of court restructuring that went awry and LightSquared was forced to file Chapter 11
  • Here is the corporate structure:
  • LightSquared has deployed two of the most powerful mobile satellites ever constructed
  • Three lines of business 1) MSAT: Mobile Satellite Communications or the wholesale service [push to talk included] 2) MDS: Mobile Data Services. "low rate data service offering primarily used for applications such as fleet and load management, email, vehicle tracking, two-way messaging and broadcast messaging and 3) PNC: Private Network Carrier. Leasing bandwidth for custom satellite data solutions. 
  • The play all along was that the proliferation of mobile would overwhelm the needs of current carrier's spectrums and LightSquared would save the day by providing their own 4G LTE network.
  • $2.3B of liabilities as of the February 29th.  Book value is listed at $4.48B
  • Spectrum breakdown is given
  • Capital Structure: LightSquared Inc Facility: $278.8M allegedly secured by a first-priority security interest in (a) the One Dot Six Lease, (b) the capital stock of each Prepetition Inc. Subsidiary Guarantor (i.e., One Dot Four Corp., One Dot Six Corp. and One Dot Six TVCC Corp.). This facility is owned by Harbinger and there is $322M outstanding as of the petitoin date. LightSquared LP Facility of $1.5B. Amounts outstanding under the Prepetition LP Credit Facility are allegedly secured by a first-priority security interest in (a) substantially all of the assets of LightSquared LP and the Prepetition LP Subsidiary Guarantors, (b) the equity interests of LightSquared LP and the Prepetition LP Parent Guarantors (except LightSquared Inc.), (c) the equity interests of the Prepetition LP Subsidiary Guarantors and (d) the rights of LightSquared Inc. under and arising out of the Inmarsat Cooperation Agreement. As of the petition date, $1.7B of this facility was outstanding.
More details related to the history of the Company and the discussions with prepetition lenders, as well as first day motions follow. On Schedule 1 of the document, the list of Ad-Hoc Secured Group of Prepetition LP Lenders (represented by White & Case) were listed as:
  • Appaloosa Management
  • Capital Research
  • Fortress 
  • Knighthead
  • Redwood Capital
Some of the most prominent distressed investors out there. LightSquared is being represented by Milbank with Moelis and Alvarez Marsal as their FAs.  Harbinger is being represented by Weil Gotshal. 

Docket #13 discusses adequate protection for prepetition secured parties. The document states that each prepetition secured party is "protected by an equity cushion" but in exchange for diminution of value in respects of the cash collateral, they will be given replacement liens, superpriority claims, and reimbursement of fees and expenses. 

Further on in the document there is discussions on the value of LightSquared:
"As the Debtors’ advisors will attest at the Interim Hearing, in these Chapter 11 Cases, the Prepetition Inc. Lenders are sufficiently protected by an equity cushion of 33% at the low end and 63% at the high end. As the Debtors’ advisors will further attest at the Interim Hearing, the Prepetition LP Lenders are also sufficiently protected by an equity cushion of 68% at the low end and 82% at the high end. Both equity cushions are significantly above the amount typically found satisfactory by courts in this and other districts."
What is the LightSquared pre-petition debt worth? I mean - that's nearly impossible to answer without further clarity on the FCC issue. If FCC clears the way, the spectrum could be worth a significant amount, especially considering Sprint doesn't hold a blocking position anymore since it terminated its agreement with LightSquared in March of this year. With 51MHz of terrestrial and LBand ATC spectrum the value could be tremendous for players looking to hole up capacity on their networks. But if terrestrial is not in the cards, value would be significantly less simply for the amount of customers using the service.

The presence of DISH network and its savvy chairman Charles Ergen has gotten more people talking about this name in the past week. If you remember, DISH was involved in the DBSD North America and Terrestar bankruptcies in the past few years (both S-band, 2 GHz). For the wireless mavens out there, we have known for some time that the S-band has no know interference issues markedly different than the L-band.  

Assets here: Satellites (one still needing to be launched) and a lot of spectrum which could be worth very little or a lot more. It looks like the majority of the spectrum is at LightSquared LP and SkyTerra (Canada), [which is 100% owned by Lightsquared LP].  At 70 cents on the dollar against $1.7B outstanding for the LP facility = lenders valuing LP at $1.2B.  If you assume that without FCC approval of terrestrial use the spectrum is worth $0.05 MHz/pop, it looks like the market is given a decent probability that the FCC allows L Band spectrum use as originally intended by LightSquared which would then sell this spectrum at a significantly higher valuation than $0.05 MHz/pop.

This is a fascinating situation, and we will try to keep you updated especially once the FA's report on the equity cushion comes to light.



The best quotes from Oaktree's first conference call

Today, Howard Marks and other executives from Oak Capital held their first conference call since going public a few weeks ago. Much has been talked about the company since its IPO including a number of prominent funds disclosing ownership in the name including the Davis Funds, Maverick Capital, Scoggin, and Greenlight Capital just to name a few  (some owning the equity when it traded on Goldman Sach's private exchange). The call was quite comprehensive, kicked off by Howard Marks discussing Oaktree's strategy and his thoughts on the market (my emphasis added):

In terms of the investing environment, I would characterize this as a relatively normal period. Having said that, I must say it makes me think of the guy who has his head in the freezer and his feet in the oven and, on average, feels okay. Today, the good news consist of the gradual recovery of the U.S. economy, as well as generally moderate asset prices and moderate investor psychology. 
On the other hand, there are plenty of things to worry about in the macro and secular sense, including the outlook for the competitiveness of the developed world, economic growth, political leadership, deficits in debt, most immediately in Europe; and China's ability to hopefully slow its growth. 
At Oaktree, we think of the market in terms of a pendulum that swings back and forth over time between unbounded optimism and limitless pessimism, and that's between prices which are too high and prices which are too low. Today we think we're in the middle of that range. We see good opportunities for most of our strategies, particularly in real estate and European distress for control. But on the other hand, distressed opportunities in the U.S. are less abundant. 
As is normal for this point in the cycle, we're focused on the areas of the economy that are showing weakness. But we also are taking advantage of the more generous capital markets to exit investments and realize profits, particularly in the area of distress debt, where as of tomorrow we will have already distributed 94% of the drawn capital of Opps VIIb, our height of the crisis fund that only entered its liquidation period a year ago. But in our control funds, most of our portfolio companies are performing well and we see no need to rush realizations at anything less than full prices.
So, net/net:
  • Fairly valued market (pendulum in the 'neutral' state)
  • Cheap assets: Real estate & European distress for control
  • Overvalued asset: Distressed opportunities in the U.S.
I think this is a consensus among those on the buy side focused on domestic opportunities in credit and distressed. At the end of the day there's really not a ton to look at here in the United States, but valuations aren't WILDLY stretched to get ultimately bearish. Professional, I do not have a mandate to invest outside the U.S.  One thing I've wanted to do for over a year now is get two writers that focus on international distressed opportunities to fill in that gap. If you are interested, contact me.

Next, CFO David Kirchheimer laid out some of the more technical aspects of Oaktree's disclosures.  An interesting point that was made here is that they account for their 22% stake in Jeffrey Gundlach's DoubleLine Capital at only $19 million (assuming that's what they gave him for working capital). Obviously that is worth far more than that today.

John Frank, Managing Principal, then discussed current opportunities and fund raising efforts.  On speaking about the strength of the market for SELLING their portfolio investments, this was a fantastic quote:

"Generally we seek to avoid buying in auctions, but we're delighted to sell through them."

Pin that one on your desk. In terms of real estate, it looks like Oaktree is doing many different things including things like commercial and land construction loans from banks in the FDIC at an average of 39 cents on the dollar. He also said that they are buying the equity of North America's larges private home builder (not sure the name).  Outside of real estate, they are also launching a senior loan product that looks to be levered (TRS?).

Moving to the Q/A, some interesting takeaways:
  • They have a little of $12 billion of dry powder ready to invest if markets get shaky
  • They were buying positions coming out of some of the European banks and are involved with the Fitness First restructuring
  • Great quote from Marks: "We don't believe in predicting the future and we especially have – if we have an inkling of what's going to happen, we never know when. So, as we sit here today, we continue to believe that real estate will provide opportunities. And we believe that one of these days, Europe and U.S. corporate distress will provide the opportunities that we've been raising money for. But none – nobody at Oaktree is going to predict that it's going to happen at any given point in time, or is going to assert unqualifiedly that it's going to happen."
  • John Frank on their European operation: 
"And a lot of what you read in the press is that the European banks, we all know the European banks have huge issues. And the, sort of, word on the street seems to be that the banks are going to become, to spew out this distress debt. In fact, we've not seen that to a huge degree. We've seen some of it. We haven't seen a lot of it.  
So what our group in Europe is doing is working, really on a company level. There are particular companies that they follow. They have a war room where they have track a large number of companies quarter-to-quarter. And what they, the opportunity that they see is that the European banks, while they may not be willing to divest their bad loans at a low rate, what they aren't willing to do, and don't have an ability to do, is to put new money into situations.  
So what our group is focused on are situations where companies have actual cash needs, have actual maturities that they have to meet or actual cash flow demands that they have to satisfy, and are in need of new capital. And our group works actively with the existing managements, with unions as necessary, with other community groups, to craft an overall solution."
  • And one final quote from Marks, that I think sums up his thoughts on the credit markets: "I think that I would say that the secondary markets are healthy but not gaga. You can get deals done, it's not land office business, but it's very healthy I think. And when I talked about moderate psychology, I mean there's a desire to put money to work, but there's also some skepticism, which – and I think that, that balance is healthy. So I would describe the credit markets as healthy."
Fantastic call. As always, its amazing to hear from the one of the world's greatest investors and a legend in the distressed community.



Distressed Debt Weekly Links of Interest

Here's what we are reading this weekend at Distressed Debt Investing

A new blog I found this week: The Brooklyn Investor: Very sharp, and impressive commentary, and a recent post on a negative stub value trade at HRG [The Brooklyn Investor]

David Einhorn is getting long Howard Marks [Market Folly]

An comprehensive guide on understanding proxy statements [Old School Value]

Another stub trade thesis recommending a long trade in Loews Corp [Value Uncovered]

Another new blog I stumbled upon that is putting out detailed notes of Peter Thiel's Startup Class at Stanford [Blake Master]

Editor Note: I am working on a Hawker post and hope to get it up tomorrow (Sunday). Have a great weekend.



2012 Ira Sohn Conference and Investment Idea Competition

On May 16th, the Ira Sohn Conference Foundation will hold its 17th annual Investment Conference with (as usual) an amazing list of speakers including:

  • Bill Ackman - Pershing Square
  • Dwight Anderson - Ospraie Management
  • Dan Ariely - Author of Predictably Irrational
  • David Einhorn - Greenlight Capital
  • Jeffrey Gundlach - DoubleLine Capital
  • Jonathan Kolatch - Redwood Capital
  • Philippe Laffont - Coatue Management
  • John Lykouretzos - Hoplite
  • Steve Mandel - Lone Pine Capital
  • John Paulson - Paulson & Co
  • Larry Robbins - Glenview Capital
  • Kenneth Rogoff - Harvard Professor
  • John Wilder - Bluescape Resources (former TXU CEO)
  • Meryl Witmer - Eagle Capital
  • And remarks by Michael Price
For those that have not attended an Ira Sohn Investment Conference in the past: It is simply an outstanding event for a wonderful cause. The Foundation, named after Ira Sohn who died of too early of cancer at the age of 29, uses its resources and fundraising to contribute to causes that move forward finding a cure for pediatric cancers as well as helping the lives of children (and their families) afflicted by these diseases.  Recipients of grants and funding include New York-Presbyterian Hospital, Memorial Sloan-Kettering Cancer Center, a fellowship in Pediatric Oncology at Cornell Medical School, etc.  To date, the conference has raised $20 million.

I highly recommend the event to all investment professionals that can attend. Not just for the amazing investment idea and pitches you will hear (it is one of the most educational experiences you'll have in your life - hearing the best of the best pitch their investment ideas) but also for a tremendous cause. For more information, please visit their homepage at: The Sohn Research Conference

Like last year, the Foundation will be conducting an Investment Idea Contest. The winner of the conference will present the winning idea in a ten minute presentation at the Sohn Conference. Judges includes Michael Price, Bill Ackman, David Einhorn, Joel Greenblatt, and Seth Klarman. Each of the 4 semi-finalist and finalist will receive two tickets to the conference. 

Investment idea entries are due by next Wednesday, May 9th. I have been working on my idea and hope all readers will apply (all entry fees also go to the Ira Sohn Foundation).  To learn more about the investment idea competition please visit the Ira Sohn Investment Competition and the Official Rules

Hope to see each of you there!



On Paradigm Shifts

Yesterday it was announced that Microsoft would make a strategic investment in Barnes and Noble's digital and college assets as part of Newco subsidiary. MSFT's $300M investment, for 17.6% of the entity, would value Newco as $1.7B, meaning BKS' stake would be worth $1.4B.  Prior to the announcement , Barnes and Noble boasted a market cap of $825M.  Obviously someone was wrong here.

A week before, a someone wrote of BKS on the Value Investor's Club. The write-up made a lot of sense, breaking down a sum of parts valuation of the enterprise. The argument had been made before: BKS is worth more broken up. But investors, as expressed by a short ratio of 50% of the flat held the viewpoint that BKS was the next Border's Group - a dying hard line retailer exposed to digital penetration of its main product. The thought that someone would value the the Nook business and college business at $1.7B would be implausible to these people.

I just got off the phone with a good friend of mine. We had a discussion whether, over the long term, being able to predict earnings beats / misses makes one a good investor. Maybe in the short run, especially those with acute trading skills. More importantly I postulated, being a good investor, in the long run, has a lot to do with spotting paradigm shifts.  That's how you make 2x, 3x, 5x, 10x on your money. You don't make that sort of money on predicting whether MSFT will beat this quarter or the next.

At work, on my desk, I have Charlie Munger's quote laid out, smack in my face: "Invert. Always Invert." A thought experiment I like try with friends, interview candidates, or just passing the time: Come up with the long thesis for the highest short interests S&P 500 stocks out there.  Currently that list includes:
  • Washington Post
  • RR Donnelley
  • Game Stop
  • Pitney Bowes
  • Frontier
  • Harris
  • Avalonbay
  • Federated Investors
  • Borgwarner
  • Plum Creek Timber
Let's take AvalonBay.  AVB is up 20% in the past year driven by increasing rents in the high end apartment space. The short thesis (plural) is pretty well understood:
  1. Rent growth is going to crack (for whatever reason) which will cause its trading multiples to collapse
  2. Along the similar lines, their large development pipeline will not translate into the growth the sell side is expecting putting pressures on multiples
  3. Its dividend yield is too low for a REIT. Higher interest rates will put pressure on the company from yield seeking investors
Let's invert these:
  1. Rent growth is going accelerate which will cause trading multiples to expand
  2. Their large development pipeline is not fully reflected in the price and multiples should expand
  3. Interest rates will stay low for a significant amount of time and AVB is in a position to expand its dividend through FFO growth
Are any of these three situations 100% out of the question?  Absolutely not. Do I believe they will happen? Me? Personally I do not. But I understand the rationale one way or the other and I can better size my position given the upside or downside potential in the 3 bearish cases and 3 bullish cases. 

From an investment standpoint, the less your paradigm shift is accepted by the marketplace, the more money that can be made from that viewpoint. One of the most lucrative paradigm shifts in the past 5 years was that Chinese RTOs are, more often that not, frauds. While you had a few people here and there in the very early years question the legitimacy of these companies, the general consensus (look at old Seeking Alpha posts) were these were thriving businesses. A paradigm shift is really a switch from an accepted, mainstream call, to one that is contrarian in nature.

Why does a contrarian make the most money in the market?  Because, believe it or not, it is the path of least resistance. Think of a spring. A spring is an amazing, amazing analogy for valuation. As you extend a string further from its neutral position, it gets harder and harder to pull it further until the spring just will not uncoil anymore. Just so, like in valuation, as valuations become more and more stretched, valuations just cannot go any further.  And because of this, the contrarian doesn't have to be as right as much as his counterparts who play for singles.  He can have a few 3 or 4 or 5 baggers, which come from a contrarian outlook, make up for many "small" wins.

I think another interesting example are the coal names. During the M&A flurry, coal names traded at a hefty, hefty multiple for such a cyclical business. To make 100% of your money from those levels would be disastrously hard. But today? ANR is flirting with an all time low in an environment where people could not hate coal more. If, or better yet, when coal normalizes, a 100% return would be a lazy Thursday.

Of course, being contrarian to just be a contrarian is a fool's errand. It espouses circular logic that inevitable would lead an investor to ruin as bad companies, inevitable cheap, do file, go away, and an investor is left with a permanent loss of capital. This is where concepts like investing in clean balance sheets or high up in the capital structure come into play because your chance of a good egg drops precipitously. Of course the 2-3-4 baggers become 1.5-2x investments but in the long run an investor that can turn out 50% on investments with limiting the zeros will far and away crush his competition.

Instead of thinking, "How are my EPS projections different than the Street's this quarter" think "In 3/5/10 years the general consensus is this company will be X.  I think it will be Y".  X could range the gamut from bankrupt to taking over the world. X will be priced in. Y is not priced in and the more radical, less accepted your vision is, the more money you can make off the investment.

Think about this next time you read a 10K and make a snap judgement about an investment. Try to argue both the bull and the bear thesis. This will make you a dynamic investor that can make money over the long run in any investing environment.



hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.